Organization's Weekly Bazaar Found to Constitute Unrelated Business Income

In TAM 201544025 the IRS decided that a foundation's weekly sales bazaar income is not substantially related to its tax exempt purpose, nor does it qualify for the rental exception for rental of real property under IRC §512(b).

The organization in question was set up to develop and support an alumni association. Its major source of income is described as below in the TAM:

While M encourages support from graduates of N, it derives substantially all of its revenue from the operation of a weekly event known as the P. The P is held in the parking areas of N's campus every Saturday and Sunday year round. N allows M to use its grounds for the P, including the use of parking lots, rest rooms, and utilities. M used the grounds without charge for two of the three years under examination.

The P features vendors offering arts and crafts, entertainment, a farmer's market, and refreshment booths. The P is open to the general public free of charge. According to a survey conducted by M, the majority of visitors to the P are age 55 and older.

Persons wishing to sell merchandise at the P must submit a "vendor space application." According to the "monthly vendor application procedures," an applicant must pay a uniform "application fee" and, if the application is accepted, a monthly "space fee" which varies according to the "season" and the size of the assigned space. If a vendor fails to occupy his or her usual space by a certain time, that space is leased to a "standby" vendor based on a lottery system.

The IRS agent in the exam claimed that this represented an unrelated trade or business, subject to the unrelated business income tax. The organization argued that it was not UBTI because it was advanced the organization's exempt purpose.

The organization's first argued that it advanced recruiting of potential students to the university, arguing

First, M states that the P contributes importantly to its exempt purposes by drawing potential student recruits and donors to the N campus, thereby serving to develop civic support for the benefit of N and to endear N to its alumni and others as potential volunteers, contributors, and supporters.

The IRS however did not accept that view, noting:

However, as the court in Living Faith, Inc. v. Comm'r observed, a merely speculative assertion that an activity is in furtherance of exempt purposes is neither self-justifying nor dispositive, and that an organization's purposes may be inferred from its activities and manner of operations. Significantly, we find nothing on the P website or in advertisements of the P that does anything more than mention that the funds raised at the P are used to provide student scholarships and to fund other programs and projects at N. Thus, aside from crediting the P with generating funds, M's own communications provide little support for its assertions that public attendance at the P serves to "develop civic support" (other than funding), "increase the size of the student population interested in N," or "endear the College to its alumni and others."

Even if we were to grant the possibility of a positive correlation between the P and an increase in admission of students to N or in the terms of endearment among alumni, M has made no showing that such correlation (as opposed to the mere raising of additional funds by the operation of the P) contributes importantly or is substantially related to its exempt purpose of developing and maintaining an alumni association for N and providing financial and civic support for the benefit of N.

Next the organization argued that it lessened the burdens of government, noting:

Second, M states that the P lessens the burdens of government because N is a governmental entity. Revenue Ruling 85-2 applies a two-part test to determine whether an organization is lessening the burdens of government. First, the organization must perform an activity that the governmental unit itself considers to be a governmental burden. Second, such activity must actually lessen the burden of the governmental unit.

The TAM also rejects this view, noting:

Applying the analysis and factors discussed in Rev. Rul. 85-2, we do not find that N considers the Pto be its burden. M maintains that N's memorandum of understanding with M as to the conduct of the P on the N campus reflects an objective manifestation by N that it considers the operation of the P to be its burden. M does not explain, and we fail to see, how that memorandum -- essentially, an indemnification agreement -- conveys that N considers the P to be its burden. Further, N does not control M. The president of the community college district that comprises N may appoint only two of M's ten directors, and has approval rights over only certain actions taken by the board. In addition, N takes no part in the operation of the P. Moreover, unlike the situation in Rev. Rul. 85-2 in which the organization assumed responsibility for an activity previously conducted by, and required of, the governmental unit, N has never engaged in the operation of a P. The P is not an activity required by N or the community college district. Finally, M receives no funding from N. The mere fact that M expends its earnings from the P in support of N does not establish the operation of the P as a governmental burden.

M states that the P furthers a charitable purpose like the operation of the public swimming pool, playground, and recreation facilities described in Rev. Rul. 59-310. In that ruling, an organization that was formed to establish, maintain, and operate recreational facilities for the children and other residents of the community -- particularly those residents who are unable to pay the cost of privately sponsored recreation facilities was found to be charitable within the meaning of § 501(c)(3) insofar as the property and its uses are dedicated to members of the general public and serve a generally recognized public purpose which tends to lessen the burdens of government. While government commonly provides public swimming pools, playgrounds, and other recreation facilities for its residents at taxpayer expense, such that an organization which provides such facilities from its own funds can be said to lessen the burdens of government, a sales event, like the P, does not have the characteristics of those public services or facilities that are normally the burden of government.

The organization's third and final argument for advancing its charitable purpose is stated as follows:

Finally, M states that the P is substantially related to M's exempt purpose because the P serves the charitable purpose of relieving the distress of the elderly. M has conducted a survey that shows that a majority of the visitors to the P are age 55 and over. M cites Rev. Rul. 77-246 for the proposition that "the elderly and the handicapped, because of advanced age or disability, encounter forms of distress aside from financial considerations." M maintains that the P serves the area's elderly population as a meeting place for social purposes where older residents of the community and visitors may meet and congregate. M states that the entertainment and musical performances that occur at the P further the charitable purpose of relieving the distress of the elderly.

One more time the TAM rejects this view. It notes:

The organization described in Rev. Rul. 77-246 is organized and operated exclusively for the charitable purpose of relieving the distress of the elderly. By providing necessary transportation for the elderly and handicapped of the community, transportation that otherwise would be unavailable or inadequate, the organization described in the revenue ruling is clearly engaged in activities that meet a special need of the elderly and disabled. By contrast, M has failed to demonstrate that the activities of the P are directed toward meeting any special needs of the elderly. M fails to identify any "special need" of the elderly that the P is supposed to address. For instance, M does not claim that, absent the P, elderly members of the community would suffer from social isolation. Although elderly persons may choose to socialize at the P, there is no indication that the P is conducted for their particular benefit or to serve their particular needs. The fact that the elderly find the P conducive to socializing is insufficient to establish a substantial causal relationship between conduct of the P and the now asserted purpose of relieving the distress of the elderly. At most, the relationship is both an accidental and incidental consequence of the P's activities. Insofar as M would have us regard the P as a social meeting place for the elderly, the analysis in Rev. Rul. 75-198 is instructive. That ruling concerned a senior center that was formed to serve the specific recreational, intellectual, social, physical, and health needs of the elderly. It provides specialized recreational activities and counseling in a facility uniquely suited to the needs of the elderly. By contrast, the activities at the P that M claims relieve the distress of the elderly -- the parking lot shuttles and the entertainment programs -- are not specifically tailored to the needs of the elderly, but are available to anyone in attendance. Moreover, the organization in Rev. Rul. 75-198 not only served as a meeting place for the elderly, but also provided information and counseling services for the elderly. We are unaware of any activities at the P that are specifically directed at serving the needs of the elderly.

For the conduct of the P to be substantially related to M's exempt purposes, it must contribute importantly to those purposes other than through the production of income [emphasis added]. Section 1.513-1(d)(2). While the operation of the P produces income that enables M to accomplish its exempt purposes, M has not shown that the operation of the P otherwise contributes importantly to an exempt purpose. Consequently, we conclude that the operation of the P is not substantially related to M's exempt purpose, but is, instead, an unrelated trade or business within the meaning of § 513.

Even if it didn't advance their tax exempt purpose, the organization argued that it would be exempt from inclusion as unrelated business income if it constitutes rent from real property pursuant to IRC §512(b)(3).

The TAM summarizes the organization's position as follows:

...M states that its arrangement with P vendors is comparable to the one described in Rev. Rul. 69-178, in which payments made under a verbal agreement to use a meeting hall for a single afternoon were determined to constitute rents from real property. Further, M cites Rev. Rul. 67-218 to contend that its right to use the parking lot constitutes an interest in real property. However, the question is not whether M's (or the vendors') use of N's parking lot involves an interest in real property, but whether the fees paid by the vendors are simply for the use of real property -- as in the case in Rev. Rul. 69-178 -- or, instead, for the opportunity to sell merchandise at an organized event that requires extensive preparation and services to stage.

The TAM does not accept this view, looking at a large number of services provided by the organization beyond merely providing space to those selling at the weekly event. It notes:

Comparing the operation of the P to leasing shopping mall space is specious because the P itself is not physical retail space; rather, it is an event. The vendors are paying not merely to occupy a space, in this case a plot of bare parking lot. Rather, the vendors at the P are paying to be part of an organized event that must be arranged, assembled, staged, and disassembled each weekend. Vendors would not lease space in a parking lot except to be part of the E. And the P would not exist but for the week-in, week-out preparations and services provided by M's employees to turn a parking lot into a successful, well-attended commercial event and back again into a parking lot. Arranging, assembling, staging, and disassembling a P are not services usually or customarily rendered to the occupant of a few square feet of a parking lot. Furthermore, even the operation of a parking lot, with its attendant services -- services that are more limited than that provided in the operation of the P -- are not treated as rents from real property under § 1.512(b)-1(c)(5).

Like the extensive "grounds maintenance" services provided by the lessor of a football stadium described in Rev. Rul. 80-298, M's employees provide extensive services to transform an empty parking lot into an attractive and efficient emporium for the vendors. Among other things, M's employees determine selling space sizes and configurations, demarcate such spaces with white lines and identifying numbers or letters painted on the ground, assign and reassign the spaces to vendors and stand-by vendors, and ensure that those vendors comply with an extensive set of space use regulations. More specifically, to ensure the successful operation of the P. M has developed, and must administer and enforce, an extensive set of rules and regulations governing the successful operation of the P. M's employees select appropriate vendors through a rigorous vendor application process. In addition, M's employees regulate vendors with respect to their selling spaces, the goods they sell, and the services they provide.

In addition, to further ensure the success of the P, M promotes the P as though it were a business and not the mere lease of real property. For instance, M advertises the P in various print outlets and on radio and television. In addition, M maintains a website dedicated to the P on which one finds a comprehensive listing of vendors. A vendor's listing is more than just a mere statement of the vendor's name, merchandise category, and location, but also includes a description of the merchandise, the vendor's website address, phone number and photo, and a link to "email this vendor."